NAFTA Renegotiation: What would ‘failure’ look like?

Other than in the (unlikely) event that the ongoing NAFTA renegotiation is successfully concluded by early 2018, President Donald Trump could find himself caught between his economic instincts and political expediency, all wrapped up in a legal tussle with Congress.

"For countless Americans, [NAFTA] has failed. We cannot ignore the huge trade deficits, the lost manufacturing jobs, the businesses that have closed or moved because of incentives, intended or not, in the current agreement.”

USTR Robert Lighthizer, August 2017

In a report I wrote recently for one of my clients, I reflected on the possibility that the ongoing NAFTA renegotiation could end in “failure”. These days I find it hard to be optimistic about trade negotiations generally and my general caution was, in this particular case, strengthened by President Donald Trump’s assertion last month that he thought that reaching agreement was unlikely and that, therefore, he “will end up probably terminating”the deal. Inevitably, this led to me being asked what it would mean if the current talks did fail, something which, I must admit, I had not fully thought through at the time.

Fortunately, on the same day as my report was published, ie 28 August, Shawn Donnan had rather a good perspective published in the Financial Times (subscriber access only) which gave me a much better starting point for coming to some (hopefully, well considered) conclusions. This article is the result.

The wider context…

The arch economic nationalist Stephen Bannon may have left the White House. But, as I have noted in previous articles for The Global Lead, his influence over the economically like-minded President is likely to remain strong. The critical point here is that Mr Bannon is a powerful voice for Mr Trump’s ‘core’ voters, to whom the President is clearly determined to pander, in the knowledge that he needs their support as an absolute minimum if he is to have a realistic chance of winning a second term in 2020.

However, herein lies a problem for Mr Trump, as Mr Donnan (among others) has pointed out. For sure, Trump voters in what used to be America’s manufacturing heartlands would probably be happy to see NAFTA scrapped. But the same is certainly not true of workers in the farming states which Mr Trump also needs to win and which have seen huge economic benefit from NAFTA. If push came to shove and Mr Trump had to jump one way or the other over NAFTA, it is not at all clear (to me at least) which way he would go.

Three “known unknowns” could play a part in determining the answer to that.

First, by the time the NAFTA parties want to see the current process concluded, ie early in 2018 (see below), will Mr Trump have achieved the major legislative success he not only craves but now urgently needs, ie tax reform (assuming, that is, that Congress first gets him over even more immediate hurdles by agreeing a spending bill and raising the debt ceiling)?

Second, where will Robert Mueller’s investigations into alleged Russian interference in the US election have got to by this time?

Both of these issues stand to have a significant impact on Mr Trump’s approval ratings and, therefore, his general conduct. In a recent FiveThirtyEight article analysing shifts in and prospects for his ratings, Nate Silver pointed out that:

“…[Mr] Trump’s approval rating hasn’t been affected much when he does something, however controversial, that’s consistent with his previous behavior”.

Mr Silver continues:

“If [Mr] Trump’s equivocal stance toward white supremacists after Charlottesville was surprising to the media, it was perhaps less so to voters…. In a poll conducted last August, 51 percent of voters described [Mr] Trump as “racist.” By contrast, the Republican health care bill was inconsistent with the promises that [Mr] Trump had made to voters on the campaign trail…. It’s not surprising, therefore, that health care hurt his numbers more than Charlottesville.”

Although Mr Silver does not specifically mention trade, it is reasonable to extrapolate from his analysis and conclude that Mr Trump’s approval ratings are likely to suffer further if he fails to match at least in significant part his pre-election commitments on NAFTA.

Third, will Gary Cohn still be Director of the National Economic Council come the start of 2018? This is important because Mr Cohn is, by all accounts, the most powerful voice in favour of free trade in the White House. Were he, as certainly seems possible, to have moved on to replace Janet Yellen at the Federal Reserve (or, alternatively, quit for other reasons) that voice in Mr Trump’s ear — a counterweight to the likes of Mr Bannon and trade ‘guru’ Peter Navarro — would be lost.

…and the immediate context

Reverting to NAFTA per se, it is important at the outset to underline that both Mr Donnan and I, in common with many other commentators, see Mr Trump’s most recent public assertion on the treaty as, at least in significant part, a negotiating ploy. As Mr Donnan remarks: “Mr Trump believes in the power of hyperbole”.

However, I would also underline as firmly that Mr Trump’s own track record gives us just as much reason to believe that he has long-standing and deep-rooted protectionist instincts; and that his dislike of NAFTA dates all the way back to when the initial negotiations were under way in the 1980s. Nevertheless, since he arrived in the Oval Office Mr Trump’s instincts (some might say prejudices) on trade have bumped very firmly into economic reality, as is perhaps most clearly manifested not only in his decision not to scrap NAFTA after all — or, at least, not in the first instance — but also the putting onto a back-burner for now at least (and in part for political reasons) his seeming det ermination to impose tariffs on steel imports from China in particular.

The process

So, instead of simply scrapping the agreement, we have what is, to be fair, a long-overdue and much-needed renegotiation of what is, after all, a 25-year-old treaty (albeit not an overhaul which is anything like as far-reaching as the US Administration would like us to believe). Two rounds of talks have already been held and a further five have been pencilled in between now and year-end. But the general consensus is that the talks have not yet got serious; that the US has still to put all its demands on the table; and that, despite the relatively limited agenda, there are plenty of potential stumbling blocks (perhaps most notably rules of origin) which make reaching agreement by year-end pretty implausible.

Worse still, not long thereafter continuing negotiations would almost certainly get even more difficult, caught up in the run-up to Mexico’s early July 2018 presidential and legislature election campaigning. By that time significant concessions to the US would play particularly badly for the country’s ruling PRI, possibly even opening the door to the presidency for the left-wing insurgent, Andrés Manuel López Obrador (aka ‘AMLO’).

Furthermore, Mr Trump will also (presumably) be keen to get this done well before the US mid-terms in November 2018.

Plausible scenarios

As I hope will become clear from what follows, once we get to the other side of the seventh meeting towards the end of this year, there are several possible scenarios which could arise. I have identified six in total and I am giving each of them a probability. But I would make it clear that these probabilities are not so much ‘scientific’ as ‘indicative’, especially at this very early stage in the process.

Scenario 1: Success!

By year end it is clear that negotiations have gone well; the process is successfully wrapped up early in 2018 without Mr Trump’s resorting to issuing a notice to withdraw.

Probability: 20%

Scenario 2: ‘Suspended Animation’

Speaking as someone who dabbled in trade negotiations on behalf of the British government in the 1990s, I am all too familiar with the barriers to reaching agreement which the domestic politics of major players can throw up. The response, assuming acceleration to beat a given ‘deadline’ cannot be reached, is usually to soft-pedal and await more propitious timing.

If the ongoing NAFTA process does drag on to around the end of 2018Q1, by which time the Mexican elections would certainly be a major issue, it would be nice to think that all three parties would at least tacitly agree to slow things down until the post-election period. But the, by then, looming mid-terms in the US seem to me to make this difficult (even though Mr Trump is not himself standing, of course).

Probability: 20%

Scenario 3: Putting their feet to the fire

This is where I am particularly indebted to Mr Donnan’s analysis. He speculates — and, I think, very soundly — that, in the absence of significant progress as we approach year-end, Mr Trump may look to up the ante by writing to Canada and Mexico giving them six months notice (which he is obliged to do under Article 2205 of the treaty) of his intention to withdraw the US from NAFTA. This would not be the final word in the President’s mind but another typical negotiating ploy.

Probability: 60%

The first problem here is, of course, that the Canadians and Mexicans have certainly done their homework on Mr Trump and will likely see this for what it is. So, the big question is: what does the President do if they call his bluff?

This is where things are likely to get very legalistic.

Mr Donnan cites international trade law expert Joel Trachtmann who believes that, under the US Constitution, “only Congress could really kill NAFTA”, on the grounds that Congress “has only delegated authority to presidents to negotiate new trade deals”, not to withdraw from them. Mr Donnan continues to the effect that unilateral action by Mr Trump could therefore be seen as usurping powers vested in Congress and noted that such a move, according to Mr Trachtmann, would:

“…provoke lawsuits by the many businesses that would be damaged by any end to NAFTA…. It would also enrage pro-free trade Republicans in Congress, particularly those in farm states.”

So far, so clear? Well maybe not.

Rob Garver, writing in The Fiscal Times in April, took a somewhat contrary position based on the 1974 Trade Act. His starting point is to ask, given the right of a “party” to withdraw from NAFTA, what actually constitutes the “party” in this particular case. He continues as follows:

“Is it [Mr] Trump? Is it the U.S. government, which includes Congress? It’s not a question that has been tested in the courts very often, but in at least two cases — George W. Bush leaving the Anti-Ballistic Missile Treaty in 2001 and Jimmy Carter terminating the Sino-American Mutual Defense Treaty in 1979 — presidents have successfully withdrawn the US from treaties on their own. [Mr] Bush’s move went unchallenged. An effort by Republican senators to block [Mr] Carter’s was dismissed for lack of standing.”

Mr Garver also argues that the 1974 Trade Act does, in fact, give the President “substantial authority to extract the U.S. from trade agreements on his own”. Nevertheless, as he goes on:

“[Mr Trump] would be required to publicly explain his decision and to allow opponents the opportunity to challenge his reasoning. The law says that ‘before taking any action’ to withdraw or alter a trade deal, ‘the President shall provide for a public hearing during the course of which interested persons shall be given a reasonable opportunity to be present, to produce evidence, and to be heard, unless he determines that such prior hearings will be contrary to the national interest because of the need for expeditious action, in which case he shall provide for a public hearing promptly after such action.’ So, bottom line, [Mr] Trump can probably pull the US out of NAFTA all by himself if he decides he wants to.”

But if Mr Trump were to do this it would be far from the end of the story, as Mr Garver readily concedes (along lines which sound to me to be not dissimilar, if not quite as complicated as, Brexit), as follows:

“…there is still the matter of hundreds of implementing regulations — based on federal laws passed by Congress — that will remain on the books if he does. It would be a hugely complicated task to restructure the country’s trade relationships with two of its largest trading partners.”

Pulling all this together, it seems to me that if Mr Trump does give notice of intent to withdraw we have four possible major variations on a theme as follows.

3A: The US succeeds in quickly extracting sufficient additional concessions from its two negotiating partners for Mr Trump to declare ‘victory’, withdraw his notification and claim that he has delivered on his pre-election pledge (ie Scenario 1 to all intents and purposes). Probability: 10%.

3B: Mr Trump’s bluff is successfully called, he suspends his notification and the negotiations continue, albeit at a slower pace until the Mexican elections are out of the way (ie Scenario 2, to all intents and purposes), hopefully to a successful conclusion not too long thereafter. Probability: 10%.

3C: Canada and/or Mexico do not concede sufficient for Mr Trump to annul his notice to withdraw, he follows through on his threat and Congress fails to muster votes to try to block him. Probability: 5%.

3D: Canada and/or Mexico do not concede sufficient for Mr Trump to annul his notice to withdraw but when he tries to follow through Congress claims that he is usurping its powers, with both Houses voting to suspend tor even annul the notice, thereby blocking the US’s exit and bringing the parties back to the negotiating table. Probability: 35%.

Not least because it is the one to which I assign the highest probability, Scenario 3D merits some additional explanation/justification. In some respects this might be the option which best suits Mr Trump. He would be able to claim that he was trying to deliver on his pre-election pledge but was stymied by Congress. He would still likely have upset Trump supporters in the farming states; but not as much as he would do if he succeeded in pulling the US out of NAFTA; and this upset would probably be somewhat offset by him (again) being able to present himself as the champion of ‘ordinary’ America’s fighting against the Washington/‘big business’ establishment (which he seems intent on doing as far as the Republican Party establishment is concerned, in any case).

Conclusion

By the President’s own admission ‘Trumpworld’ is very binary being made up of ‘winners’ and ‘losers’. In US politics arguably the ultimate definition of a ‘loser’ is a President who fails to win a second term. Given his obsession with ‘winning’, on NAFTA, as with all things, Mr Trump will be determined to go with whatever best serves his reelection prospects whether it is in America’s better interests or not. One way or the other, we should hope that whether the US remains in NAFTA or not is not ultimately be determined by personal rather than the national interest.

The bottom line? Although I put a less than 50% probability on Mr Trump achieving his negotiating objectives (whatever they may be in detail), I currently see no more than a 5% probability of the US leaving NAFTA.